Impact of Iran Sanctions Legislation: An Energy Perspective

Q: Two weeks ago, the US House and Senate both overwhelmingly approved legislation (HR 2194) authorizing the president to sanction businesses that supply Iran with refined petroleum products or help Iran to produce them.

How does this legislation target the energy sector, and how effective is it likely to be?

A: The energy-related provisions are designed to strengthen a 1996 law that penalized foreign firms investing $20 million or more in Iran’s energy sector. In addition to the energy provisions, the measure also provides penalties for financial institutions that do business with Iran’s Revolutionary Guard Corps or with Iranian banks identified by the U.S. Treasury Department.

Proponents of the legislation argue that the bill will hit Iran where it hurts most and therefore persuade Iran’s leaders to abandon their plans to develop nuclear capabilities. But skeptics conclude that, at least in terms of energy implications, the legislation will have limited reach, at best, and could actually be counterproductive both in terms of achieving international cooperation on an effective sanctions regime and in polarizing the attitudes of the Iranian public against the leadership.

The bill requires that the president impose sanctions on any company providing Iran with refined petroleum products (diesel, gasoline, jet fuel, aviation gasoline, etc.) valued at $200,000 or more per transaction, or $1 million cumulatively in a year.

The Obama administration and some in Congress have emphasized that any sanctions should be directed at the government only, not the Iranian public. In reality, this legislation is likely to achieve the opposite outcome. Gasoline sanctions will ultimately hurt the Iranian people, both at the pump and through the economic impact of the sanctions. While the Congress believes that the pressure will turn the Iranian public against the regime, a convincing case can be made that the sanctions will serve as a unifying event and allow the leadership to direct the public’s anger at the United States.

Iranian president Mahmoud Ahmadinejad has tried to rationalize energy prices over the past two years, but the tense political climate in Iran has forced him to move slowly. Ironically, U.S. sanctions provide him with political cover to lift subsidies on gasoline. The government began implementing a gasoline rationing system two years ago that allowed each vehicle a fixed amount of subsidized gasoline. The quota is lowered over time, forcing drivers to purchase additional fuel at international market prices.

Iran has the third-largest proven oil reserves in the world, but the country’s refining sector is in such bad shape that the government actually imports refined products. Until recently, estimates of refined product imports were at 40 percent. While it is certainly true that the energy sector plays a key role in the Iranian economy (roughly three-quarters of the government’s revenues come from oil exports) and that internal fuel needs are a key point of vulnerability, Iranian leaders are acutely aware of this and have taken concrete actions to address those concerns.

Over the past few years, the government has begun an expansion of its domestic refining capacity, reduced the domestic consumption of gasoline by rationalizing prices and restricting supply purchases with “smart cards,” built up sizeable volumes of strategic stockpiles (80 days’ worth by some accounts), and begun exploring options for developing alternative transport fuels. As a result of these policy measures, Iran’s imports of refined products have dropped to 30 percent, according to some estimates.

Iranian stockpiles of refined product have increased because of import purchases from a variety of sources, including India, China, Turkmenistan, and other countries. Because of the price differentials, overland shipments of gasoline are also believed to have come from suppliers in neighboring Iraq. Consequently, there is not a high degree of confidence that the application of additional sanctions will appreciably stem those flows.

Frank Verrastro is senior vice president and director of the Energy and National Security Program at the Center for Strategic and International Studies (CSIS) in Washington, D.C. Nitzan Goldberger is a research associate with the CSIS Energy and National Security Program.